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Macro Unit II: Measuring Economic
PerformanceMcConnell and Brue chapters 6, 7,
and 9
Macroeconomic Goals and the Business Cycle
An Introduction to Macroeconomic Indicators
Important Macroeconomic Questions
O Why does output fluctuate?O What determines economic growth?O Why do we have unemployment, and why is
unemployment a problem?O Why do we have inflation, and why is inflation a
problem?O Which governmental policy affects output,
growth, unemployment, and inflation?O How do changes in the amount of money in the
economy affect output, growth, unemployment and inflation?
O How do domestic economic activities affect other counties and our trade?
Why does output fluctuate?
O As output rises and falls, amount of goods and services people have increases and decreases
O Thus, standard of living rises and falls, and people are better off or worse off
O Changes in output cause changes in the number of people employed
O Macroeconomics looks at the determinants of output fluctuation and how these factors can be controlled
Unit 2 : MacroeconomicsNational Council on Economic Education
Real GDP 1952-2001(in billions of 1996 dollars)
What determines economic growth?
O Just as fluctuations in output affect the standard of living from year to year, the long-run growth in output is important for society’s welfare.
O Growth in an economy depends on the number of workers, the education and training of workers, the technological advances, the amount of machinery and technology labor has to work with, and the basic material resources.
O Macroeconomics addresses how society can encourage the development of these factors, which determine economic growth.
Why do we have unemployment, and why is unemployment a problem?
O The unemployed are people who are actively seeking jobs or are temporarily laid off.
O The question usually arises, “Why won’t these people work for a lower wage and thus get a job?”O Some unemployed people do not have the skills firms require
and are unable to find a job even at a lower wage.O Some unemployed people do have skills and want to be paid
the market wage for these skills, and they are willing to continue to search for a job until they find one.
O Some of these people are unemployed because firms do not have the need for additional workers because demand for their product is down.
O Firms will typically not fire existing workers to hire new workers at a lower wage because doing so endangers worker loyalty and also increases the firm’s training costs.
Why do we have unemployment, and why is unemployment a problem?
OUnemployment is not simply a problem for the unemployed.
OUnemployment means that society has fewer products because these workers are not working.
OUnemployment also imposes social and psychological costs on society.
Why do we have inflation, and why is inflation a problem?O Inflation is an increase in the average price
level over time.O One of the difficulties with inflation is its
unpredictability.O If people knew what inflation was going to
be, they could build in adjustments for its effects.
O Macroeconomics studies the causes of inflation, the misallocation of resources that result from inflation and methods for controlling inflation.
Which government policy affects output, growth, unemployment
and inflation?O Fiscal policy is a summary of the
government’s decisions about expenditures and taxation.
O Government decisions about taxes and about how much it will spend affect the level of output, growth, unemployment and inflation.
How do changes in the amount of money in the economy affect output, growth, unemployment
and inflation?O The decisions of the central bank — the Federal Reserve in the United States — determine the amount of money in the economy.
O The amount of money in the system determines to a great extent the level of economic activity.
O The amount of money in the economy (money supply) in conjunction with how much money society wants to use determine the interest rate.
O Monetary policy is a summary of the Federal Reserve’s decisions about money and interest rates.
How do domestic economic activities affect other countries
and our trade?O A nation’s economy does not operate
independent of other countries’ economies.
O Trade policies, monetary policies, and fiscal policies all affect the impact of the domestic economy on the economies of other nations.
O In the next lesson the economic basis for trade is explained.
Think about this…O What causes output to rise and fall?
O What causes unemployment to rise and fall?
The Business CycleO What is it?
O Recurring increases and decreases in the level of economic activity over periods of years
O Consists of peak, contractionary (recession), trough, and expansionary (recovery) phases
The Business CycleO The business cycle describes
economic fluctuations:O the rising and falling of output in
relation to potential output.O Potential output: level of output
that the economy can sustain given the capital stock, technology and full employment
Unit 2 : MacroeconomicsNational Council on Economic Education
Phases of the Business Cycle
Phases of the Business Cycle
O Recession is defined as two consecutive quarters (six months) of negative growth in real GDP.
O The point at which output starts to decline is called the peak of the cycle, or the beginning of the recession.
O The point at which output starts to increase is called the trough, or the end of the recession.
O As the economy moves forward, the period between the trough and the next peak is called the recovery period or expansion.
The Business CycleO Business cycles are defined in terms of
outputO However, other variables follow the
movement of outputO Investment and consumption both rise and
fall with movements in real GDPO Inflation typically declines during
recessions and increases as the economy approaches the peak.
O The unemployment rate rises sharply in recessions.
The Business CycleO Interesting phenomena occur with the
unemployment rate over a business cycle.O Initially, the unemployment rate risesO If the recession lasts a long time, the
unemployment rate remains at a high level or might actually decline as discouraged workers leave the ranks of the unemployed
O As the recovery begins, the unemployment rate may remain very steady at a high level
O As the economy recovers and people find jobs, other people enter the labor market looking for work and thus the unemployment rate remains steady
Important Points about the Business Cycle
O There is no consistent length of time for each phase
O Business cycles are unpredictable. After the fact, economists can identify some of the causes of business cycles but are notoriously poor at predicting the actual downturn.
O Some variables are countercyclical: move in the opposite direction from real GDP. Some variables are procyclical: move in the same direction as real GDP.
So, how is the economy is doing right now?
O UnemploymentO Nationally: 5.1% (nationally)O Georgia: 5.9% (state)O Natural Rate of Unemployment: 5.05%
(FY15 Q4)
O InflationO The Consumer Price Index for All
Urban Consumers (CPI-U) for Atlanta down 0.1% over July-August pricing period
O CPI-U up 0.6% for the year
The Circular Flow Model
What do firms provide to households?
O GoodsO Services
What do households give firms in return for the goods and services?
O Payment for goods and services
What do households provide to firms?
O Resources (all owned by households)O LandO LaborO CapitalO Entrepreneurship
What do firms provide households in return for the
resources payments for goods and services?
O WagesO RentO InterestO Profit
The Circular FlowO The circular flow model shows the
household, business, financial, government, and international sectors of the economy, and the basic interactions among the sectors.
O The value of the flow of goods and services must equal the value of the flow of resources in the circular flow model.
The Circular Flow and GDP
O Gross Domestic Product measures the total market value of all final goods and services produced in a country in one year.
O We use GDP as a measure of production in the economy because it can be measured by either the top or bottom flow.
O Measuring the top flow is the expenditures approach (measuring the amount spent for goods and services), and using the bottom flow is the income approach (measuring the payments to households for resources).
Unit 2 : MacroeconomicsNational Council on Economic Education
Circular Flow
Unit 2 : MacroeconomicsNational Council on Economic Education
Circular Flow
Macroeconomic Goals
• Full Employment
• Price Stability
• Economic Growth
• In general, the goals conflict, so society is faced with trade-offs among the goals
Unit 2 : MacroeconomicsNational Council on Economic Education
Full EmploymentO The unemployment rate is a broad
measure of economic activity.O However, if policy makers are going
to create and implement programs to help the unemployed, they need to know more about the unemployed: O skill levelO ethnic and racial groupsO age groups.
Price StabilityO The CPI measures the price level; and
from this, the inflation rate can be calculated.
O The CPI is only one of several price level measures.
O There is discussion about how well the CPI measures the inflation that most people experience. The CPI includes items that people don’t buy every year: house, car, etc. Thus, the CPI may overstate the actual change in the cost of living.
Gross Domestic Product
O Gross Domestic Product (GDP) is the most widely reported measure to indicate a country’s economic performance
O GDP is the market value of all final goods and services produced in a nation during a specific period of time, usually a quarter or a year
Points to remember when measuring GDP…
O Secondhand transactions are not included (no new production)
O Transfer payments are not counted i.e. welfare doesn't produce anything
O Intermediate goods not included (i.e. bread yes, flour no)If any of these items were included,
the measurement of economic activity would be subject to “double-
counting”
Calculating GDP
O C = Consumption expenditures by households
O I = Investment expenditures by firmsO G = Government purchases of goods
and servicesO = Net exports (exports minus
imports)O Sometimes instead of you’ll see (X –
M),
Economic GrowthO The growth rate in real GDP is a
better measure of the change in the macroeconomic conditions than the growth rate of nominal GDP because nominal GDP includes the effects of inflation.
O The growth rate in real GDP per capita captures a measure of changes in the standard of living.
Short-run versus long-run economic growth
O Short-run growth measured in terms of fluctuations in output
O Fluctuations in output are measured by the changes in real gross domestic product from quarter to quarter or year to year.
O In general, fluctuations in output are caused by greater or lesser utilization of the existing capital stock and technology.
O So we are actually measuring changes in real output because of more or less labor applied to the existing level of technology and plant and equipment.
O Long-run economic growth refers to changes in the productive capability of the economy through changes in the amount of plant and equipment and technology.
Short-run versus long-run economic growth
O Economists use the term economic growth to refer to long-run economic growth and fluctuations in real output to refer to the short-run phenomenon.
O However, the media frequently refer to short-run changes in output as economic growth.
O NOTE: The AP Macro Examination uses the term economic growth to refer to the long-run changes in the economy’s ability to produce.
Price Indices and Inflation
PricesO Name some prices that have
changed in your lifetimeO Prices that have increasedO Prices that have decreased
Percentage Increase 1962-1998
Item Percentage Increase in Price
Hershey bar 1180%
New York Times 1100%
First class postage 700%
Gasoline (gallon) 284%
Hamburger (McDonald's double) 861%
Chevrolet (full size) 790%
Refrigerator freezer 60%
How does the quality of each item compare from 1962 to 1998?
What have we learned so far?
O Prices can/do change dramatically in relatively short periodsO Price from past can become virtually
meaninglessO Prices of items do not go up
consistentlyO Some go up faster than others
O Items change over timeO Becomes difficult to compare prices
because the items are not really
InflationO Inflation: a rise in the overall price level.
O While the overall level of prices in the economy increases during inflation, individual prices may go up or down during periods of inflation.
O No obvious quality improvementO Okay as long a our income increases at
same rate or higherO If not, not as well off as we thinkO Also important – financial planning
O $100 today will not buy as much in 20 years
Inflation’s effects on $1.00
Anticipated versus Unanticipated Inflation
O Anticipated inflation: the level of inflation people expect to occur and have built into their economic decisions
O Unanticipated inflation: the level of inflation that is not expected or is unforeseen
O Wage contracts and long-term loan contracts are usually the source for judging the expected inflation rate
Unanticipated InflationO Unanticipated inflation causes
economic costs because people have not adjusted earnings and expenditures for this level of inflation
Unanticipated InflationO Some people gain and some lose from
unanticipated inflation.O Great example: borrowers and lenders
O Borrowers gain and lenders lose from unanticipated inflation because the money that is paid back at a later date (with interest) will not buy as much as it did before the inflation.
O Also, people with fixed payments lose as a result of inflation because the payment stays the same but prices are higher after inflation.
O Finally, the government is the largest borrower in the economy and therefore gains from inflation (despite the fact that it tries to prevent inflation).
Anticipated InflationO People adjust to anticipated inflation
by building it into their wages, interest rates, and other decisions, so no redistribution takes place.
O However, high levels of anticipated inflation also have economic costs: shoe-leather costs, menu costs, and unit of account costs.
Anticipated InflationO Shoe-leather costs refer to the cost
of having to run around trying to avoid losses from the declining value of money (even if the “running around” happens online).
O Menu costs occur when businesses have to adjust their prices upward as a result of inflation.
O Unit of account costs arise because inflation makes money a less reliable measure of measurement.
Consumer Price IndexO Way to compare prices in different
yearsO Economists choose a “bundle” or
“basket” of goods in varying proportionsComponents of the CPI(U)
Housing 41.4%
Transportation 17.8%
Food 16.2%
Energy 8.2%
Medical Care 6.4%
Apparel and Upkeep 6.1%
Other 3.9%
CPI ContinuedO The cost of the bundle is assigned an
index numberO The following year the cost of the
same bundle is determinedO CPI for that year = new cost of
bundle
Official CPI 1990-2010
YearCPI
1982-84=1001990 130.71991 136.21992 140.31993 144.51994 148.21995 152.41996 156.91997 160.51998 163.01999 166.62000 172.22001 177.12002 179.92003 184.02004 188.92005 195.32006 201.62007 207.32008 215.32009 214.5
O How to read the tableO Used to compare
prices of any two years
O Example: same goods that cost $130.70 in 1990 would cost $172.20 in 2000
O So $130.70 in 1990 = $172.20 in 2000
Initial Index value = 100 and represents average CPI of 1982-84
Relationship Between Factors
Can calculate how much more the prices of goods were in one year than another
Calculate the ratio of the CPI values
So, goods in 2000 cost 1.302 times more than in 1990 (on average)
2000 CPI = 170.2 = 1.302 1990 CPI 130.7
Converting to Constant Dollars
Comparing amounts from 2 different yearsCan convert any money related variables
◦ Prices, wages, salariesCurrent prices for each year are called
nominalCompare prices taking changing value of
money into accountConvert one price to same year as other
◦ Usually convert forward to more recent year
Example The price of gasoline in 1990 was $1.16
per gallon on average. In 1997, it averaged $1.22. Was gasoline more expensive or less expensive in 1997? ◦ 1990 $130.70 equivalent to $160.50 in
1997◦ 1997 CPI = 160.5 = 1.23
1990 CPI 130.7 So $1.00 in 1990 = $1.23 in 1997
◦ Multiply 1990 value by 1.23 (1.16 * 1.23) So $1.16 in 1990 = $1.42 in 1997
Another ExampleO Your boss said she made $25,000 a
year at her first job out of college in 1993. That doesn't sound like a lot of money to us today, but we must consider that everything was less expensive in 1993.
O What is that salary worth in today's money (in 2010)?
Compare Prices in Consecutive Years
O Convert entire series of prices to constant dollars
Electricity Prices 1986 - 1997
Electricity Prices (US city average, per KWH)
Year Price
1986 $0.077
1987 $0.079
1988 $0.080
1989 $0.082
1990 $0.084
1991 $0.087
1992 $0.088
1993 $0.092
1994 $0.092
1995 $0.094
1996 $0.094
1997 $0.094
As a Graph…
Is this a realistic depiction of the price of electricity?
1984 1986 1988 1990 1992 1994 1996 1998$0.05
$0.06
$0.07
$0.08
$0.09
$0.10
Electricity Prices 1986-1997
Year
Pri
ce
Huh?O Did price of electricity increase
really?O Value of dollar decreased each yearO Nominal cost increasedO What about constant dollars?O Convert 1986 values to 1997 dollars
to find out
CPI Graphs
Time (years)
Change over time
Time (years)
Change over time
Time (years)
Change over time
$ increases at same rate as inflation (ex. Milk, bread, salary)
$ increases slower than inflation (ex. electricity)
$ increases faster than inflation (ex. Gas or cigarettes)
Calculating Inflation Rate
O Inflation rate is defined as O the percentage change in the CPIs
from the previous year to the next.
O Inflation Rate in 2008 wasO 2008 CPI – 2007 CPI
2007 CPI
O 215.3-207.3 = .0386 or 3.86% 207.3
Negative Inflation (or Deflation)
O When the price of goods drops over timeO Good thing? Bad thing?
O Not always goodO Example:
O 2008 new car costs $30,000O 2009 expected value is $15,000O 2010 expected value is $7,500O Would you purchased a car in 2008 knowing it
would cost you less in 2009 or 2010?
O Result: consumers stop buying cars, wait for the price to drop more industry dwindles
Unemployment
Unit 2 : MacroeconomicsNational Council on Economic Education
Definitions of Employed, Unemployedand Unemployment Rate
Employed = everyone currently working, including part-time workers
Unemployed = people looking for work or temporarily laid off from work
Unemployment Rate = unemployed
labor force
Labor force = employed + unemployed
Labor force participation rate = labor force
population aged 16 and older
In and Out of the Labor Force
O EmployedO Currently holds a full- or
part-time jobO Includes those who are
underemployedO Unemployed
O Not working but activelyO seeking workO FrictionalO CyclicalO Structural
O ChildrenO RetiredO Full-time student (not
working)O Choose not to workO Not actively seeking
workO Stay-at-home parentO InstitutionalizedO Discouraged workers
INthe labor force
OUTof the labor force
Important points to remember…
O Unemployment includes people who are actively looking for work. People who have stopped looking are not counted as unemployed.
O The labor force consists of the employed and the unemployed.
O The labor force participation rate is the proportion of the population over age 16 who are looking for work or who are working.
Issues with unemployment
O The definition of unemployment itselfO No mention of discouraged
workers: people who were looking for work but gave up because they didn’t succeed in finding a job
O Unemployment rate underestimates, by the number of discouraged workers, the number of people who would like to work
Issues with unemployment
O Underemployed workersO The underemployed are people who
are working part time but would like to work full time, or who hold a job that requires a lower skill level than they possess
O These people are considered employed, but they could be more productive in a different job
Issues with unemployment
O Different groups within the economy experience vastly different rates of unemploymentO The groups may be age cohorts, or
race or ethnic categoriesO Knowing the distribution of
unemployment by a particular characteristic is important in constructing policies to help the unemployed
Types of Unemployment
O Frictional Unemployment – when people are out of work TEMPORARILY due to moves between jobs, careers, and locationsO Ex.: Mr. White’s wife gets promoted, but
job is now in Connecticut. Mr. White is frictionally unemployed until he finds a teaching job in CT.
O Mr. Sad Class quits because he hates his job, but he hasn’t found a new job yet…
Types of Unemployment
O Structural Unemployment – when workers have PERMANENTLY lost their jobs in a certain industryO Many miners are now permanently
out of work because machines to the jobs miners used to do
Types of Unemployment
O Cyclical Unemployment – when there is not enough demand for all those that want to workO Due to swings in the business cycleO Ex.: autoworker laid off in recession
due to dwindling demand for new cars. When demand for cars goes back up, will probably be rehired
O THIS IS THE UNEMPLOYMENT MACRO POLICY MAKERS PRIMARILY ADDRESS
Other Employment Concepts
O Natural Rate of Unemployment – level of unemployment when there is no cyclical unemploymentO Frictional and structural employment
still existO Varies from country to countryO In the US, the Organization for Economic
Cooperation and Development (OECD) estimates natural rate of unemployment to be around 6.1%
Other Employment Concepts
O Full Employment– level of employment when the economy is at the natural rate of unemployment
O FULL EMPLOYMENT IS NOT AN UNEMPLOYMENT RATE OF ZERO!!!O By law, US is committed to full employmentO According to the Full Employment and
Balanced Growth Act of 1978, US is committed to an unemployment rate no greater than 4% for persons over the age of 16
O IS THIS REALISTIC???
